ARM loans, or Adjustable Rate Mortgage products, all have a feature known generally as "caps" which can greatly influence the amount your payment can go up immediately after the fixed introductory period on your ARM (the "teaser" or "start rate") expires or comes to an end.

The most common caps are divided into Interest Rate Caps and Payment Caps.

The adjustment caps of Adjustable Rate Mortgages are usually explained in plain English in the Adjustable Rate Rider, which is a part of the mortgage closing documents.

AIf you are looking at an ARM program, be sure to ask what your current "Fully Indexed Rate" is. This is your margin plus the current index rate.

Here is an example of what common rate caps might be on conforming loans, loans for people with good credit. On an ARM loan you may have rate caps that are 2% and 1%, or written as 2/1 Caps. What exactly does this mean, why are there two caps listed, and how do rate caps work are very common questions. There are 2 numbers listed because generally the first cap number that is listed has to do with the first rate adjustment period of your loan. Therefore, the 2% listed above would mean that your interest rate can not adjust up or down by more than 2%. So if you had a ARM loan at 6.5% and a 2% cap on the first adjustment, the most the rate could go up on that first adjustment would be 8.5%. Now the 1% number that is listed second is intended to be the rate cap for the remainder of the adjustments on loan, after the first adjustment. This means that for every adjustment thereafter the first one, your interest rate would not be able to increase or decrease by more than 1%. This is one example of how ARM adjustment caps can work on ARM loans.

While all ARMs have "caps" for the amount the interest rate can adjust upwards, some also have a "floor" rate, which is the lower end limit of what the interest rate can adjust to. Few people are aware that some Adjustable Rate Mortgages can also adjust to a lower interest rate.

Most SubPrime ARMs the floor rate is the same as your original rate. For conforming ARMs, the floor rate is usually the same as the margin of your interest rate

Even though the interest rates may drop, your monthly payment may not always drop accordingly. If your ARM has an interest rate cap, your rate (and payment) may be held below what it would have adjusted to, had the full change in the index rate been applied. In this case, the increase in interest that was not applied due to your cap may carry over to future adjustments to your interest rate. This is referred to as a carryover. This means that the next time your adjustment period hits, your monthly payment will increase, even if the index has not changed.

ARMs have a life time "cap" assocciated with the rate as well. This represents the highest interest rate you could ever have on the loan. This is typically 6% above your original fixed start rate.

ARM caps can vary from lender to lender.

If you are unsure of your ARM adjustment caps you can always refer back to your ARM rider in your closing documents. The ARM rider will give you all the information about your ARM when it enters its adjustment period. If you are still unsure you can always call your mortgage broker to help you understand the ARM rider document.